BABY, WE NEED TO INCORPORATE: A case study of whether to take the Big Plunge with your business partner
It’s pathetically New Economy of me, but my big commitment beef recently wasn’t with my honey (a tasty music grad student, not just Old Economy but marvelously Un-Economy)—it was with deciding what to do in my small business partnership. My compadre and I run a venture together, a NYC Internet networking party called Smartypants Cocktail Hour (www.smartypantsny.com), and we need to decide whether to incorporate. Friends, I’m your personal guinea pig on this matter: let’s discuss.
A business partnership is a fluctuating, in-motion kind of thing, so it’s hard (maybe total folly) to prescribe the order of priority for doing certain stuff. However, the really critical issues facing partners start when the venture begins to incur significant costs and attract potential revenue. In other words, money changes everything. Boiling it down, the decision to incorporate hinges on the following:
1. how many bucks you can expect to spend out and take in for the venture (and the tax implications that creates),
2. the working nature of the partnership (who does what, how much each partner invests, all the daily and future concerns of running a business), and
3. potential liability, whether "liability" means the old "slip and fall" scenario where the partnership could be sued for an accident, or when it means incurring debt as partners.
I began with Nolo.com and USLaw.com, both stellar law-for-the-rest-of-us sites covering in fair detail the various ways of structuring a partnership and pros and cons of each. Beginning at the casual end of the spectrum, you have the sole proprietorship, in which a single person or married couple owns and runs the business, taking on total personal responsibility for debts and suits and passing through tax gains or losses to a personal income tax statement. This arrangement usually requires only that proprietors fill out a special tax form each year along with their personal tax stuff.
Next you have partnerships, general or limited. General partners own the business together, and each partner has a say in managing the business and takes on responsibility for debts / suits. Again, tax consequences for the business pass through to the individual partners’ income tax returns. In limited partnerships, a limited partner is so-called because liability for debts and suits is generally limited to the amount of investment they made into the business. Participating in managing the business means being a general partner with all the rights and full liabilities already mentioned.
At another level of formality you have the limited liability company (LLC), which can combine the liability benefits of a corporation and the ease and low expense of a partnership. LLC owners are protected personally from debts and suits liability but can set up the LLC in such a way as to enjoy fairly sweet tax rates. This ain’t a deal you slap together in your basement, however; an LLC requires a more formal process of filing LLC Articles of Incorporation with the Secretary of State in the state of your choosing. All states allow individuals to file articles on their own without lawyers, and that great invention, the Internet, can make the whole process relatively painless.
Finally at the all-grown-up level, we have setting up a Corporation. Your main choices here are regular or S corporations, professional corporations and non-profits. Professional corporations (and for that matter, limited liability partnerships , or LLPs ) are usually chosen by old-guard professions like law firms or medical practices, where individual partners want personal protection from the malpractice suits other partners might incur. Non-profits, of course, must be organized for charitable, scientific, educational, literary or religious purposes only (and baby, your ability to kick back on the lilypads of Easy Street is nobody’s idea of a charity, so don’t play it unless you’re legit). The benefits: no income tax for the corporation, and contributions to the corporation are tax-deductible to donors.
Regular corporations are the big mama of businesses: their owners are generally protected from debt and lawsuit liability (although most small business owners must co-sign for corporate debts, becoming personally liable to a degree). Being a corporation isn’t the easy panacea, though: negligence as a corporation could still get you sued; your corporation’s income is taxed twice, at the corporate level and again at the shareholder level, in the form of personal income tax on dividends; it’s a mild headache to incorporate, and then some. ( S corporations are different primarily in that they are taxed only at the shareholder level.) But for a business gearing up for truly considerable costs and liabilities and where the revenue could really be coming in, incorporating is perhaps the most stable form your business can take.
Incorporating requires first that you apply for a charter, or certificate of incorporation, from a state government of your choice. (Some states are reputably sweeter for incorporating than others, Delaware being arguably the most popular. Just remember that you must have a registered agent in the state you choose to collect mail and notices from the government relevant to the corporation.) You then file articles of incorporation stating the purpose of the corporation and the powers of the owners. A corporation can be as simple as a single person operation, where that person is the only owner and shareholder, or you can slice and dice and develop a board of directors who direct the business; officers who run the business day-to-day; and shareholders who own shares of the business but do not participate actively in running it. And then of course, the corporation is primed to potentially sell a portion of its shares to the public and become a publicly held corporation.
So the big heavy conclusion? Smartypants decided to stay a general partnership and pen a partnership deal to organize ourselves and how we work together. Our costs are minimal, debts are zero, and revenues are modest (we have one paying sponsor lined up and a few in discussions). We’ve discussed having a lawyerly friend help us include wording on our website that limits our liability for "slip and fall" accidents at events we organize (an unlikely scenario, anyway). Now, just don’t sue me for saying any of this and we’re positively golden.
YOU GOTTA READ MORE ON THE FOLLOWING:
Writing a partnership agreement. USLaw.com has a kick-ass checklist of things to hash out with your partner and include in your document; you can write this by yourselves but might want to slip by a lawyer for a look-see just to confirm you’re copacetic.
Or, for a mere fee of $25, you can use their “build a document” format and in 30 minutes, you’re styling with a document worthy of signature. This feature includes a bunch of other made-to-order legal templates fora variety of business and personal purposes. I’m not a lawyer and can’t vouch for their quality, but for this kitten’s money it’s worth checking out with a lawyer-esque friend. (http://www.uslaw.com/build-a-document/one-channel?channel_id=47)
OTHER SMALL BUSINESS POCKETS-O-GOODNESS:
Guru.com. Especially for free agent types with an Internet bent to their business, this site covers all kinds of small business matters from tax and employee matters, getting paid, structuring independent contract deals, and getting gigs or finding independent workers for your project.
—Jude Stewart for Green magazine, June 1999
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